Bank of America's Penalty Misses the Point

The U.S. Justice Department just got Bank of America Corp. to pay about $16 billion to settle charges of selling defective mortgages to investors.

The size of the penalty is impressive, and it comes on top of Justice's other recent big-bank fines, including JPMorgan Chase & Co.'s $13 billion and Citigroup Inc.'s $7 billion. All told, Bank of America will have forfeited about $70 billlion to end legal actions over mortgage lending, much of it stemming from its 2008 purchase of Countrywide Financial Corp.

In one way, Wall Street has paid dearly for the misdeeds that led the global economy to crash in 2008. But has the cause of justice been well served? That's debatable.

None of the settlements holds individuals to account. Shareholders and insurers are covering the bills -- and the penalties include mortgage buybacks, refinancings and the like that may never reach actual victims. The banks haven't been made to plead guilty to crimes. Because the settlements were worked out in secret with no judicial oversight, the lessons for future bankers are murky, making the deterrent effect doubtful. Such settlements also hold little legal sway over other judges.

Did it have to be this way? Consider a less-noticed civil-fraud case that just concluded.

In October, a jury found Countrywide and a senior mortgage banker, Rebecca Mairone, liable for fraud for having sold thousands of bad loans to Fannie Mae and Freddie Mac. Last week, U.S. District Judge Jed Rakoff ordered Bank of America to pay $1.3 billion in that matter. The sum was relatively modest; more striking was the judge's commentary. Rakoff said the Countrywide loan-approval program was "the vehicle for a brazen fraud by the defendants, driven by a hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole."

This case is the only one in which a large bank has had to defend its conduct in the housing boom, and it challenges the idea that bringing fraud prosecutions in this area is a hopeless endeavor. Apparently juries can cope with financial complexity after all. An assistant U.S. attorney explained what went on at Countrywide without needing to dwell on the arcana of collateralized mortgage obligations.

Testimony revealed, for example, that as the housing boom was ebbing, Countrywide substituted software for human judgment to process mortgage applications on a fast track. Loans were approved in as little as 10 days, versus the normal 60, in a program called "high-speed swim lane." The bankers abbreviated that to HSSL -- and pronounced it "hustle." The program lasted only nine months yet managed to write almost 30,000 subprime mortgages, which Fannie Mae and Freddie Mac bought for about $5 billion. Defect rates on stated-income loans (in which the borrower's income isn't verified) reached 70 percent.

Other reasons, aside from complexity, have been advanced to justify the lack of prosecutions. One is that the U.S. government was itself involved because of its housing policies. The trial showed it was Countrywide, not a U.S. official, who told loan officers not to screen out risky borrowers and to fill their quota of applications before going home at night. It was Countrywide that rewarded bankers with the speediest approval rates, no matter how poorly underwritten their loans.

The idea that well-shielded executives can't be implicated also got debunked. Testimony emerged that Mairone silenced and penalized bankers who complained about the quality of hustle loans. Rakoff is requiring Mairone to personally pay her $1 million penalty. Perhaps most important, the case suggests that midlevel employees could have been persuaded to give evidence against their seniors, enabling prosecutors to move up the chain.

Countrywide bankers complained bitterly to Mairone in March 2008 when Chief Executive Officer Angelo Mozilo testified to Congress that the bank was carefully screening all its applicants to minimize defaults. Mozilo never faced trial. A criminal investigation was quietly dropped in 2011, and he avoided a civil trial when he agreed to pay $67.5 million, only a third of which came out of his own pocket, in settlement.

The jurors in last year's trial sent out a note during deliberations asking why more senior Countrywide executives weren't being sued with Mairone. Many American taxpayers, homeowners and investors cannot be blamed for wondering the same thing.